Masonry Magazine June 1985 Page. 10
WASHINGTON WIRE
continued
Be sure your assets are protected by Federal, rather than state, deposit insurance. And take delivery of all securities you won't sell soon; do not leave them with your broker.
THE BACKERS OF TAX REFORM are finding it hard to fire up the public to support the proposals currently getting consideration on Capitol Hill. Many individual taxpayers say that they like the concept of simplification and of reducing bracket rates. They tell their lawmakers that it's nice. But they don't seem ready to write to Wash-ington, demanding quick passage. Actually, many seem more interested in protecting their present advantages such as deductions of mortgage interest or exemption of fringe benefits. They seem to believe that their loopholes are worth more than lower rates.
Does this mean that indifference and active lobbying can kill reform? Possibly. But Ronald Reagan can still save it, say knowledgeable experts. He'll have to fight hard for it, however... as hard as he did for the MX missile.
A GROWING GLUT OF OFFICE SPACE should let business hold down rents over the next half-decade. The supply will climb while demand levels off. New construc-tion is likely to continue high, fueled by a desire to beat out any tax-reform provision that renders real-estate shel-ters less attractive. Private investors, pension funds, etc., have discovered the possible profit. The need for new space, however, is being limited as many companies become more efficient in use of existing facilities fewer square feet per person. Further, fewer new workers will be needed as la-bor-force productivity rises. Vacancy rates could exceed 20% in certain areas during the late Eighties.
CORPORATE PROFITS are likely to repeat the mod-erate rise of 1984-up roughly 8%, after taxes-during the four quarters of the current year. That will be substantially less than the prodigious 49% surge seen in 1983, the first full year of this expansion. But earnings always tail off as upturns mature, and 8% would be a very respectable showing.
How a Valuator Would Price Your Business
If you wanted to know the value of a used car, the person most likely to know is a used-car dealer-because he is constantly selling used cars to customers. If you wanted the value of real estate, you would talk to a realtor-who is constantly selling property to customers.
So, if you want a value on a business, you must talk to a business broker or acquisition consultant-who is con-stantly selling businesses. A valuation by anybody other than a broker is a third party's guess at what a broker would tell you. A "valuation" by you, or your accountant. is almost certain to be rejected by a buyer and merely result in counter offers and endless haggling.
A valuation serves only one purpose: to predict, with a high level of accuracy, what a knowledgeable buyer would be willing to pay and what a knowledgeable seller should be willing to accept. Since there are far more experienced buyers than sellers (many buyers buy more than one busi-ness; most sellers only sell once), it follows that it is best to approach valuation from the viewpoint of a buyer. What a buyer would be willing to pay is the value.
How a Valuation Is Made
There are three prices or "values" provided by a com-plete valuation study of the entire business. First is the Liquidation Value. This adds the current assets to the auc-tion value of the equipment, real estate and inventory, and subtracts the liabilities. Its purpose, actually, is to project a buyer's financing, which assists in setting terms of the sale. The second is the Fair Market Value-essentially the same, but presuming a more leisurely (and advantageous) sale of the assets and is a projection of a buyer's down-side (loss) risk.
But the real value (for setting the sales price) is found by analyzing the Earnings-how much a buyer should be willing to pay for the cash-flow stream over which the owner has control. This has very little to do with the profit which the owner shows the IRS (or even the lack of a profit). Instead, the valuator takes that taxable profit and then adds back all "discretionary" expenditures-interest, depreciation, the owner's salary and fringes, profit-sharing and pension plans, contributions; part of the T&E, dues and subscriptions, vehicle expenses, and so on.
This produces a number which is the cash flow after absolutely unavoidable expenses. From this, he deducts a reasonable manager's salary, and absolutely necessary purchases of new equipment. The result is the Operating Earnings-defined as the amount of money over which the owner had control, after paying himself a manager's salary.
To this is applied a multiplier which depends upon the interest rate and performance of alternate investments. Not surprisingly, the buyer wants a much higher return with the risk inherent in any business, plus his time and managerial involvement. Currently, buyers expect about 30-35% return, equivalent to a 3x multiplier. So th the av erage earnings are multiplied by this and the result is the Earnings Valuation.
Often there are assets which do not contribute to the earnings-real estate, underutilized equipment, too much inventory, excess cash, etc. These are an add-on to the value. The result is what a buyer should pay for all assets and liabilities. That is, part of what he spends goes to creditors and the rest goes to the seller. So subtract the liabilities from the valuation to get the net-to-seller CASH value.
Cash sales seldom happen, so the next step a much more involved process is based upon determining the results of a range of typical deals very high downpay ment (say, 50 to 75%), very low downpayment (say, 5%. although the seller's taxes create a downside floor), and an average 20-40% down. The installment-sale value is al-ways higher than the cash value. Played against various interest rates and time periods, the actual "value" grows out of the various terms, whether or not the seller will stay, and if so, for how long, etc.
The true marketplace "value" of a business is a nebu-lous thing, far more influenced by the buyer's perceptions of risk and future prospects (and the terms of the deal) than by the inherent value of the assets involved.
The foregoing is based on Report #515-"How a Val-uator Would Price Your Business." It is free to any busi-ness owner/executive who sends a $1.00 bill, to cover postage and handling, to the Independent Business Insti-tute, P.O. Box 159, Akron, OH 44309.